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October 6, 2018

On the beaten track


October 6, 2018

The economy is in a hole and the government seems to be at a loss on how to pull it out. Being on the prowl to cut down on spending, the ruling party is selling some of the PM Office’s most ‘precious’ assets – buffaloes and cars.

Although eye-catching, such foppish transactions are doomed to be inconsequential in addressing the burgeoning economic problems. Going by the recent forecasts made by some international institutions of repute, the economy may relapse into stagflation – an unenviable combination of low growth and high inflation – that puts to test even the most astute of economic managers.

Some of the leading international institutions are witnessing an economic slowdown in Pakistan. The London-based international credit-rating agency Fitch has forecast that economic growth will decelerate to 4.7 percent during the current financial year (FY 2019) against the budgetary target of 6.2 percent, and further to 4.3 percent in FY 2020. The Asian Development Bank, World Bank and the IMF estimates have put economic growth at 4.8 percent, 4.7 percent and 5.2 percent, respectively, during the current financial year. The SBP has estimated a growth forecast of five percent for FY 2019.

Economics has been called – and for good reason – the science of rational choice. In a world of scarcity, every policy decision represents a trade-off between competing ends. Restrictive fiscal and monetary policies may help contain fiscal and current account deficits – the twin deficits as they are called – but they do so at the cost of putting the brakes on economic growth.

Currency depreciation may be instrumental in driving up exports and winding down imports, but it also stokes inflation and, thereby, increases the cost of doing business and revalues the external debt. Policymakers have to decide which end they are going to put the premium on. The PML-N government adopted monetary and fiscal expansion, which accelerated economic growth, and scaled-up fiscal and current account deficits.

The last financial year (FY 2017-18) closed with GDP growth of 5.8 percent, fiscal deficit of 6.8 percent, and current account deficit of 5.7 percent. The PTI government is also facing a similar set of choices. Their initial policy decisions prefigure at least three things: a preference for stabilisation over growth; reliance on the sale of state assets to swell the size of the treasury; and going back to the IMF to salvage a critical balance of payment (BoP) position.

It is customary to classify economic policies into expansionary measures and contractionary ones. Expansionary policies aim to accelerate the growth rate while contractionary policies are calculated to stabilise the economy. Expansionary policies are undergirded by cuts in interest rates and taxes, and an increase in government spending. Contractionary policies – referred to as stabilisation and structural adjustment policies in IMF parlance – are underpinned by a hike in interest rates, and taxes and cuts in government spending.

In Pakistan, economic policies move around in circles, corresponding to political cycles. During the 1990s, pushed by the IMF, contractionary polices were followed in the country. As a result, the average annual economic growth rate contracted to 4.6 percent from 6.5 percent in the 1980s. During first eight years of the last decade (FY 1999-2000 to FY 2007-2008), the Musharraf period, expansionary polices were pursued. Hence, the average annual growth expanded to 5.5 percent. The PPP government, which took office in May 2008, reverted to stabilisation policies. As a result, between FY 2008-09 and FY 2012-13, economic growth on average decelerated to three percent.

The PML-N, which was elected to power in June 2013, put its trust in expansionary polices and during its five-year tenure (FY 2013-14 to FY 2017-18) the economy began to look up as the average growth rate went up to 4.8 percent. The last two financial years, FY 2017 and FY2018, ended with relatively high growth rates of 5.4 percent and 5.8 percent, respectively. And now, the PTI government is set to pursue contractionary policies.

The expansionary polices draw a lot of flak on the ground that they result in high fiscal and current account – including trade – deficits. For instance, FY 2007-08 ended with fiscal deficit of 7.6 percent and current account deficit of 8.47 percent. Likewise, at the end of 2017-18, fiscal and current account deficits of 6.8 percent and 5.7 percent were recorded. In 2008, the twin deficits stampeded the government into seeking a bailout package from the IMF. Likewise, faced with large deficits on the fiscal and external fronts, the present government is desperately looking for hefty foreign assistance.

Such criticism is valid, but only to an extent. By pumping up domestic demand, which is partly met by an increase in imports, expansionary policies creep up trade and current account deficits. Since an increase in government spending is met by borrowing, it breeds fiscal deficits. At the other end of the scale, economic development requires sustained growth. When growth shrinks, investment goes down, jobs are lost and incomes fall.

In addition, stabilisation policies may also set off imbalances. The stabilisation polices of the PPP government led to a fiscal deficit worth 8.2 percent of GDP and a trade deficit that stood at 8.9 percent of GDP at the end of FY 2013. Why do stabilisation policies fail to hit the bull’s eye? The answer is that such policies are pursued half-heartedly. They fail to address the structural economic constraints, broaden the tax base, or bring down public expenditure. More than 70 percent of the public expenditure is soaked up by three heads: debt-servicing, defence, and general administration, which collectively go up in nominal terms, even if they don’t increase in real terms.

Likewise, every government decides to restructure and finally sell loss-making public sector enterprises (PSEs). Such moves, which will entail substantial lay-offs or, at the very least, a reduction in perks, is opposed by employees and the parties on the other side of the political divide – not to mention the considerable opposition to these measures within the ruling party. Finally, the government sees ‘reason’ and instead of privatising or shaking up the ramshackle organisations, it begins to use them as a means of extending political patronage.

Faced with such a situation, the government has limited cost-cutting and revenue-generating options: curtail development spending, ratchet-up indirect taxes, or raise the rates of direct taxes, which are deducted at source. Such measures end up by slowing down the pace of the economy. This is essentially what the PTI government has done in the amendments to the Finance Act 2018, referred to as the mini-budget, whereby income tax rates and regulatory duties (indirect taxes) have been increased and development spending cut. Gas prices have also been raised while a hike in electricity prices has been put on hold, presumably because of the pending by-elections. Taken together, such measures will build up inflationary pressures and hold down economic growth.

In a related and widely predicted decision, the State Bank of Pakistan (SBP) has raised the policy rate, commonly known as the interest rate, by one percentage point to 8.5 percent in the Monetary Policy Statement (MPS) for October-November. This is the third consecutive increase in the policy rate. In May 2018, the policy rate was increased by half a percentage point to 6.5 percent while it was hiked to 7.5 percent in July.

The upward movement of the policy rate portends that the stage is being set to strike another credit agreement with the IMF, which would be the third in 10 years. Pakistan’s external-financing needs for the current fiscal year are estimated to be at least $9 billion. And it is only through a bailout package that such needs can be fulfilled. As substantial and immediate assistance from another country is difficult to come by, an agreement with the multilateral donor seems to be a fait accompli.

The writer is an Islamabad-based columnist.

Email: [email protected]

Twitter: @hussainhzaidi

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